As a publicly traded company, we are required to value our portfolio of investments on a quarterly basis. We believe this level of frequency provides well-deserved transparency to our current and prospective shareholders. Recently, there have been some new sources of volatility in our values than existed in prior quarters, so we thought it might be helpful to discuss these sources of this volatility and provide some general background regarding the process for valuing privately held securities in a series of blog posts. This first post will provide an overview of these sources of volatility. In future posts, we will dig deeper into each source of volatility.
Just as a refresher, we value our portfolio companies according to generally accepted accounting principles for investment companies. This process involves the efforts of a substantial portion of our team complemented by input from the Valuation Committee of our Board of Directors and from a firm that specializes in valuations.
We have historically seen volatility in our individual portfolio company values and overall net assets primarily owing to changes in terms of new financings and discounts related to non-performance risk. In recent quarters, the following sources have played a role in this volatility:
- Option pricing models are now being used to derive overall equity values and to allocate these values across the different classes of securities of many of our portfolio companies. We began using option pricing models as part of valuation process as of the end of the third quarter. As of December 31, 2014, we use option pricing models to value 12 of our private portfolio companies.
- More of our companies are reaching a state of maturity where it is appropriate to calculate the value of the company based on a multiple to revenue. These multiples are derived from a set of publicly traded comparable companies and are therefore subject to the volatility inherent in the public markets. As of December 31, 2014, two of our top five companies by value, including our largest holding, Adesto, were valued using this approach.
- We have at least one large investment, Enumeral Biomedical Holdings, which is publicly traded. Additionally, Enumeral is a microcapitalization company that trades over-the-counter. These two factors increase the volatility in its stock price and the value of our holdings of the company.
Our next post will dig into option pricing models and provide context for why valuations calculated by option pricing models may not increase if 1) rounds of financing occur at higher prices per share, 2) liquidation preferences include multiples on investment, 3) the amount of invested capital is small and/or 4) liquidation preferences are senior to prior rounds of financing. We will also discuss why investors and companies may pursue financing terms that may negatively impact our value in the near term, but may be beneficial to realizing value in the long run. These types of scenarios can occur regardless of the stage of the company.